U.S. Recessions Don’t Start in the Third Year of a Presidency

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At a lunch for professional investors and advisors last week, Philip Orlando delivered a well-rounded argument against a U.S. recession in the near term. Economic growth may well slow down, but he doesn’t anticipate two consecutive quarters of negative gross domestic product growth until 2021 or 2022.

Orlando, senior vice president, chief equity market strategist at Federated Advisory Services in Pittsburgh pointed to a number of customary indicators to make his point. Annual wage growth sits a little north of 3% right now, short of the 4% that in his view would signal a downturn two years out. And while the yield curve (the difference between the U.S. 10- and 1-year Treasury Notes) narrowed last year, it hasn’t inverted, which is a sure sign recession is in the cards.

He also detailed historical precedents having to do with the U.S. election cycle that are less often a part of these discussions.

“Over the last 70 years … there have been 11 post-war recessions in the U.S. Not a single recession was started in the third year of the presidential election cycle,” he said. “The presidents of either party – Democrats or Republicans, everybody does it – knowing that there is a big presidential election coming up the next year, they grease the skids. They want to make sure there is enough monetary policy and fiscal policy stimulus to the system that the economy does well, that the financial markets do well. That way the voters, next year, are predisposed to vote favourably for their party. So we’ve never had a cycle of decline – a recession – in the third year.”

Canadians have seen two pre-recession peaks during the third year of a presidential term in recent years: in 1947 and 1951.

Orlando also quoted U.S. stock market numbers. “The average S&P 500 return in year three is up 21%,” he said. “That’s double the average of years one, two and four. The third year of the cycle, historically has been the most productive year in the four-year cycle. We think that’s going to happen again this year.”

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Orlando did allow for the fact that political risk has to be factored into financial planning. “Robert Mueller is the ultimate black swan,” he said.

“We’re looking at March as a very important month. March 1 is the China-U.S. trade deal deadline. March 20 is the next [Federal Open Market Committee] meeting; the next set of dot plots out of the Federal Reserve. We need to see some conciliatory movement toward some sort of neutral position. And then the Brexit deadline is March 29. If we can get past March with at least two of those three – I’m saying China and the Fed in place and maybe some progress on Brexit – I think the volatility that we’ve seen in the market over the last six months or so will be behind us and we’ll be in much better shape.”

Kevin Press

What Happened to Global Stocks?

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I was in to see an old friend from the wealth management business yesterday. Historically, global equities have been an important part of his firm’s investment focus. But the sector’s consistent poor performance is having exactly the effect you would expect.

“I’ve got this big leaky boat,” he said to me. That can only mean one thing in the money management business: clients are withdrawing their money and taking it elsewhere. Redemptions.

“We’re busy building a new boat inside the leaky boat.” That means his firm is developing new investment strategies to attract investors burned by global stocks.

What happened? The numbers below from The Wall Street Journal Market Data Center highlight how broad-based the downturn was in 2018. Keep in mind these are year-to-date numbers. Long-term investors (which includes anyone saving for retirement), should never overreact to one-year returns.

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Still, it’s important to understand what’s going on. A lot of this negativity came up in the fourth quarter of last year. Does all this red ink signal an incoming global recession?

Opinions are split. Some believe this correction has brought stock prices down to a more reasonable level. In fact, we have seen signs of a turnaround since the holidays. It stands to reason that stock valuations would come down as central banks push interest rates up.

Others are worried about weakening manufacturing numbers and the nearly inverted yield curve. That’s a measure of the difference between the U.S. 10-year and 1-year Treasury Notes.

Typically, investors demand a higher yield on 10-year notes because they have to wait longer to cash out. When investors lose confidence in the short-term economy, that gets turned upside down. They have less confidence in short-term bonds so they demand a higher yield. We watch the U.S. Treasury Notes because recessions in that country have such a consistent impact on the global economy (particularly ours here in Canada).

In a note to investors yesterday, RBC Wealth Management’s Jim Allworth wrote: “We would point out that the yield curve has not yet inverted … and it is not a forgone conclusion that it will in the near future.”

The bank predicts that the U.S. will “go on growing into and perhaps through 2020.”

Yesterday’s edition of Scotiabank’s Global Outlook struck a similar tone. “Our forecast currently calls for global growth to slow from 3.7% in 2018 to 3.5% in 2019. However, the evolution of equity markets through the fall, along with movements in the yield curve suggest a much greater markdown in growth is anticipated, including possibly a recession in some countries. … Our own recession probability model for Canada, which considers a range of economic and financial variables, suggests the risk of a recession remains very low.”

The report goes on to note that there would have to be some kind of “trigger,” such as a worsening of the U.S.-China trade relationship to make recession likely.

So while stock markets are flashing warning signs, there is no consensus that a recession is around the corner. And again, one-year returns should never drive dramatic changes in a diversified investment portfolio designed to achieve long-term goals.

Just the same, keep an eye out. This is a good environment to be managing your expenses carefully and giving some thought to an emergency savings fund.

Kevin Press

Welcome to Today’s Economy

image 2019-01-09 at 6.18 pmHere’s a promise.

I’m going to do my best to help Canadians understand what’s happening in the economy – at home and around the world. I’m not here to sell you anything. I have no agenda beyond wanting to help readers understand the world just a little bit better so that they can take care of the ones they love.

A bit about me. I’ve been writing about economics, household finances and retirement planning since the mid-1990s. I was a journalist initially, and then joined one of the country’s top insurance companies as a marketing/communications leader. Both experiences taught me the value of learning and the feeling of confidence that comes from having even a rudimentary understanding of how money works.

You’re going to see a few key themes covered in this space:

  • Expect a recession sometime soon. This year marks the 10th consecutive year of economic growth in Canada. Yes, we’ve been mired in an extended period of slow growth since the financial crisis. Just the same, we’ve seen positive numbers every year since 2009. That’s not normal. The C.D. Howe Institute reports that economic expansions have averaged about half a dozen years each since The Great Depression.
  • Interest rates matter more than ever. Low rates began to emerge as an issue for long-term investors in the 1990s. But that was nothing compared to the super-low rates implemented by central banks around the world to spur growth after the financial crisis. The Bank of Canada announced today that it will maintain its target for the overnight rate at 1.75%. Like other central banks, they’ve been working to inch that rate up. (Canada’s key rate hit a low of 0.5% in 2009.) But they have to tread carefully. Rising rates slow economic growth, so of course the risk is that they will tip the economy into recession. But if/when a recession does occur, central banks need to have room to lower rates in order to help the economy recover. You can’t do a lot of cutting when your starting point is less than 2%.
  • Navigating all this means understanding risk. That goes beyond traditional investment risk. Canadians are living longer than ever. That means longevity risk, which is to say that you might outlive your savings. In a connected world where government decisions often have global implications, political risk is significant. Canadians who invest in the U.S. market are well aware of currency risk. There is much to consider.
  • All of this is affecting how Canadians plan for the future. That’s especially true for long-term savings goals like retirement. Don’t be surprised if you’re still working at 70. And don’t be put off by that. It may be the best thing for you.
  • More than ever, it’s up to you and me. Employers have been stepping back from the old-school, paternalistic approach they’ve historically taken with retirement, life and health insurance benefits. Much has been written about the move from defined benefit to defined contribution pensions for example, which puts the onus on individuals to make investment decisions. The discontinuation of retiree benefits is another big story. It’s not clear how this will play out as baby boomers continue to enter retirement. Few expect governments to fill the gap, but it’s too early to make bold predictions on that. Obviously though, we have to be prepared to take care of ourselves to an extent that our parents weren’t required to.

If you’d like to see something covered, please shoot me a note. And if you know someone who will value Today’s Economy, please share.

Kevin Press